Leon's Furniture Ltd T.LNF

Greystone Capital Q3, 2024 letter

[Possibleidiot01]

New Positions
During the quarter I added significantly to our holding in Leon’s Furniture Limited. I will use the
remaining portion of this letter to discuss the investment in more detail.
Leon’s Furniture Limited (LNF.TO / LEFUF)
Decades ago, furniture retail was very much my family’s business, as my great grandfather inherited a
furniture store, H. Feinberg Furniture Co., from his father in the early part of the 20th century. The store
employed many family members, including my Uncle, who later ran the store with his wife for many
years, and my Dad, who worked as a salesman before and after college. Although financial details are
sparse, two store locations made it possible, according to a 1924 issue of the Wilmington Evening
Journal, for ‘the firm to absorb entire factory productions, thus enabling it to enjoy advantages in
buying not possible with stores whose purchases are limited to carload and trainload lots.’ That was
the 1924 version of scale. Unfortunately, two locations in the deteriorating cities of Chester, PA and
Wilmington, DE didn’t stand the test of time, but as a certain value investor demonstrated, well-run
furniture stores with scale can be excellent investments.
Warren Buffett purchased Nebraska Furniture Mart (‘NFM’) from the legendary Rose Blumkin in 1983,
paying $60.5mm, or about 16.0x pre-tax earnings. I could fill the rest of this letter with stories about
Rose herself as she was quite a character (I’ll spare you), but the purchase was much more than a bet
on the jockey. Buffett was interested in scale economics. It’s safe to say the investment was a homerun,
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Greystone Capital Management | [e-mail] | www.greystonevalue.com
as just a year after the purchase, pre-tax earnings for NFM were $21mm, and today Nebraska Furniture
Mart is one of the largest and most profitable furniture stores in the US.
NFM achieved that mark by following a simple, but hard to replicate formula for success (from
Berkshire’s 1989 Annual Report):
- Unparalleled depth and breadth of merchandise at one location;
- The lowest operating costs in the business;
- The shrewdest of buying, made possible in part by the huge volumes purchased;
- Gross margins, and therefore prices, far below competitors’, and
- Friendly personalized service with family members on hand at all times.
This formula created a loyal customer base that enjoyed wide selection, convenient shopping and low
prices, allowing NFM to scale considerably while widening their competitive moat.
From Berkshire’s 1984 Annual Report:
“By unparalleled efficiency and astute volume purchasing, NFM is able to earn
excellent returns on capital while saving its customers at least $30 million annually
from what, on average, it would cost them to buy the same merchandise at stores
maintaining typical mark-ups. Such savings enable NFM to constantly widen its
geographical reach and thus to enjoy growth well beyond the natural growth of the
Omaha market.”
The powerful feedback loop for NFM consists of low prices at the stores, which attract customers,
enabling the business to generate high sales per square foot (via high asset turnover ratios) while
achieving scale advantages in the form of low prices from suppliers, passed onto the customers in the
form of ever lower prices, thus attracting more customers…and so on.
While not considered a low-cost retailer, I believe Leon’s Furniture is a functional equivalent of NFM,
where scale enables similar competitive advantages compared to the rest of the industry.
Like NFM, Leon’s possesses the following attributes:
- Unparalleled scale and operating footprint
- Significant cost and purchasing advantages over competitors
- Wide selection, availability and friendly customer service
- A family run business with a focus on the customer
- Advertising scale and efficiencies leading to strong customer traffic and high market share
Leon’s is a 110-year-old furniture retailer, now the largest in Canada, holding the #1 positions in
furniture, #1 in appliances and the #2 position in mattress sales. Since its founding, Leon’s has been
family owned and controlled by the Leon family, where founder Ablan Leon and his sons grew the
business from a single store on a street corner in Welland in 1909, to a 302-store behemoth now doing
over $2.5 billion in annual revenue. The majority of stores are corporate owned (202) while the
remaining locations are franchised, which has been a strong business for Leon’s, enabling them to
enter into smaller geographies with high quality operators in areas where other furniture retailers were
not successful. An important part of recent history includes Leon’s purchase of their largest competitor
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Greystone Capital Management | [e-mail] | www.greystonevalue.com
in 2013, The Brick. Revenues have tripled since that period, and the acquisition brought with it
significant scale, top line growth, and geographic diversification.
Today, I estimate that Leon’s controls slightly above 15% of Canada’s retail furniture market, which I
think can grow to 25% within the next decade. In conjunction with further market share gains, Leon’s
has several internal initiatives set to drive sales and margins upward from here. These include
optimizing their store footprint and square footage, centralizing their distribution, growing their
warranty and insurance businesses, and monetizing their vast portfolio of real estate holdings,
discussed in more detail below.
Despite the cyclicality of the furniture industry, Leon’s has separated itself from the pack by
demonstrating remarkable durability during its history, with stable margins and zero unprofitable
years during the past two decades. This, along with strong returns on capital, has led to a
compounding of earnings per share of greater than 8.5% during the past 10 and 20 years. I believe
there is plenty of runway for continued growth.
The history of Canadian big box retail (of which Leon’s and The Brick were some of the first concepts)
reveals that large format stores generally gain 10-20% market share each decade, sometimes more,
which they’ve driven upwards as a category from the low-30s in 1980 to 60-70% today. For furniture
specifically, these market share gains should disproportionately accrue to Leon’s. Despite low barriers
to entry, furniture retailing is a very tough business. One doesn’t have to look far to read about waves
of bankruptcies during each cycle, along with an industry history that reveals many hopefuls trying
and failing to operate successfully, including Magnavox, Beatrice Foods and even General Mills, to
name a few. As a result, the number of retailers has declined for more than a decade as larger
competition (Sears, Eaton’s, Zellers, etc.) has gone out of business, while smaller mom and pop
operations face challenges with economies of scale and supply chain issues, along with generational
business transfer problems with children who aren’t eager to enter the family furniture business.
As a result, continued decline in supply along with industry cycles will benefit Leon’s, as weaker
competitors exit the market or go out of business, allowing the company to absorb additional square
footage or incremental sales in certain geographies. A good example of this dynamic is playing out
so far this year, where despite housing, consumer and industry softness, Leon’s reported positive same
stores sales growth through Q2, likely absorbing incremental sales following the bankruptcy of smaller
competitor, Bad Boy Furniture.
More importantly, Leon’s sits in an important part of the value chain to consumers, given longstanding
changes to both manufacturing and distribution among furniture manufacturers. Today, furniture
brands have all but disappeared (I would struggle to name the brand of any piece of furniture in my
house) given fragmentation, outsourced manufacturing, constantly changing consumer taste and little
to no marketing presence. Despite some product differentiation, retailers are mostly brand agnostic
and view most product lines as fungible, able to be swapped out for something better at any point in
time. As a result, retailers now hold all the power, and in a market with a dominant retailer, all roads
go through them. Therefore, Leon’s controls access to the market, not only as the largest player, but
also as the de facto retailer to introduce new brands into Canada. A recent partnership with mattress-
in-a-box company Resident is a great example of Leon’s using their owned distribution and store
footprint to allow Resident to connect with their customers in exchange for marketing dollars, pushing
potential Resident customers to Leon’s stores. This of course results in zero customer acquisition costs
for any mattress or furniture purchases made on a visit.
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Greystone Capital Management | [e-mail] | www.greystonevalue.com
Leon’s advantages will widen over time. The company consistently ranks in the top ten TV advertisers
in the country, often surpassing Tim Hortons and even McDonald’s in certain geographies. I estimate
that Leon’s spends around $100mm annually on marketing, which they can ratchet up or down
depending on market conditions, dwarfing their competitors spend.
Like the NFM case study, scale benefits will continue to accrue. Leon’s is currently the largest importer
of shipping containers into Canada, providing them with massive purchasing cost advantages when
compared to their competition. Leon’s pays around 1/3rd of competitor pricing for a standard 40 ft.
shipping container, while maintaining standard markups, enabling them to post gross margins
significantly in excess of mom-and-pop operations, and on par with some of the best run retailers in
the US. I estimate Leon’s cost structure to be significantly favorable compared to the average mom
and pop operation in terms of both purchasing power (gross margins) and operating expenses per
unit. The average mom and pop store must mark their prices up significantly just to breakeven on a
per unit basis, while Leon’s can use their cost advantages to offer everyday low prices and sit on the
value end of the spectrum, further widening their competitive advantage. In addition, relationships
with over 500 suppliers and a wholly owned logistics subsidiary means Leon’s has on the ground
presence in Asia, another leg up over competitors. These advantages were demonstrated during the
pandemic, where Leon’s scale and purchasing power made them one of the only furniture retailers
who could obtain available product.
As mentioned, Leon’s has been family run since it’s founding, with the Leon family still owning and
controlling 70% of the business. Many members of the family, starting with founder Ablan Leon’s 11
children, have passed through the business in various roles, with grandson Terry Leon most recently
serving as long-time President and CEO.
The Leon’s have been excellent stewards of capital (likely due to their large ownership stake),
highlighting my preference for owner-operator led businesses, and have proven to be excellent
operators during the past few decades. They also implemented a compensation structure that is rare
among family-owned businesses, with fair base salaries and no egregious stock-based compensation.
They are true owners of the business and have treated the capital as such.
One area in which they have historically fallen short is investor communication. Don’t get me wrong, I
love a healthy disdain for Wall Street. But in this case, I believe both the strength of the business along
with the potential value is not being captured in the current price. I also believe it will start to be
recognized shortly.
In 2021, following a 6-year stint with the business as a VP of Operations, Leon’s hired Mike Walsh as
CEO, making him the first ever non-family member CEO to take the reins. Since his hiring, Mike has
quickly demonstrated his skill as an operator and capital allocator, meaningfully adjusting Leon’s
inventory assortment coming out of COVID, returning significant amounts of capital, and putting a
plan together to unlock significant shareholder value. Mike was also behind the recent IR push, serving
to highlight the strength of Leon’s business. Mike has an extensive track record as a successful
Canadian big box retailer, and we stand to benefit from his skillset in the foreseeable future.
All in all, the furniture business has a long runway for continued market share gains and cash flow
generation, with some internal projects that could also boost margins over time. I would be a happy
shareholder of the furniture business alone, at the price we paid.
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Greystone Capital Management | [e-mail] | www.greystonevalue.com
But there’s more.
As a result of their large store footprint, Leon’s is currently sitting on a portfolio of 12.2mm square feet
of residential and industrial real estate, 5.6mm of which is owned, unencumbered. Many of these
properties were purchased decades ago, with value rising in accordance with historical increases in
real estate prices. Currently, the entirety of this real estate sits on Leon’s balance sheet at a value of
$275mm.
In May of 2023, Leon’s unveiled their plan to unlock the value of their real estate via IPO, which will
commence in line with favorable market conditions, likely by year end 2025. Importantly, this is the
same strategy that was enacted by both Loblaw Companies and Canadian Tire, two of Canada’s
largest big box food and retail businesses, who spun off their portfolios of real estate in 2013. Using
similar prices per square foot and measured against current market data, I value Leon’s real estate
portfolio to be worth somewhere between $1.2 – $1.6 billion. The current market value of the business
is $1.8 billion.
Not only will the IPO serve to unlock the value of the real estate by providing a public valuation but
will also provide Leon’s with a sizeable chunk of cash to be used for buybacks and/or a special
dividend. With limited reinvestment needs and shareholder friendly management, I believe a decent
windfall will be doled out to shareholders following the transaction. Although there will be a negative
impact to earnings and cash flow in the near term due to increases in lease payments following the
transaction, Leon’s will collect sizeable distributions from the REIT, partially offsetting these lease
payments, and should more than make up for it with increased market value.
Lastly, to finish icing our cake, one of Leon’s distribution centers and corporate headquarters sits on a
40-acre lot in prime downtown Toronto, the monetization of which is currently underway. Leon’s plans
to partner with developers to build 4,000 homes in addition to a new corporate headquarters. The
land has already been converted from a general employment area to a regeneration area, and
secondary approval to move forward with a development plan will likely be granted in 2025.
Maximizing that parcel of land will require the building of residential, high-rise, low-rise, rental units
and town homes, and will likely result in a value between $200-400mm to the company.
Amazingly, our purchase price for the business inclusive of all the assets was less than 6.0x EBITDA
and 9.0x free cash flow. As Leon’s continues to grow, optimize the store footprint, centralize
distribution, and unlock the value of the real estate, I believe earnings power will increase, and both
the strength of the retail business and the value of the real estate will shine through. Capital returns
will be another catalyst, as Leon’s has returned nearly $1.0B to shareholders between dividends and
buybacks during the past decade, even repurchasing 10% of shares outstanding during 2022 alone.
One industry insider pointed out that the furniture business is one with ‘low barriers to entry and high
barriers to exit’, meaning there are plenty of ways in, but the only way out is through success. Leon’s
has demonstrated their success thus far and we are betting on its continuation. Given our large margin
of safety and favorable risk/reward profile, Leon’s is now positioned within our top five holdings.
As always, please feel free to reach out anytime if you would like to further discuss the business or our
investment.
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